Are directors’ loan accounts safe?

Current as of August 2017

 

The majority of our clients that run their business through a company structure use directors (or shareholders’) loan accounts.

There is nothing necessarily wrong with this if you understand them, and we would have discussed these with you in the past.

These loan accounts arise when funds are taken from your company in the form of a loan, rather than paying yourself a wage or a dividend (if you are also a shareholder).

The benefit of this for the company is cash flow – as there is no PAYG withholding or compulsory superannuation or workers compensation liabilities associated with loans. Additionally, if not a dividend then the “top up” tax in the shareholder’s hands is deferred as well.

There is the problem which we have brought up in the past, of the loan becoming an unfranked dividend under Division 7A of the Income Tax Act – if the loan is not dealt with in the way required by the Act.

But what happens to these director loan accounts if the company gets into financial problems and a liquidator is appointed?

It is likely the liquidator will demand the director repay the loan to the company so he can use those funds to pay creditors.

The Director can only be protected from this situation if a dividend has actually been declared to offset the cash actually taken out by the director/shareholder, and it has been correctly declared. If no dividend was declared before the liquidation then the liquidator will demand repayment.

This could then lead to problems for the director/shareholder if they have used the money and they are unable to repay it. The liquidator will pursue this debt strongly and won’t hesitate to bankrupt the director/shareholder if they cannot or will not repay the debt.

A short term company cash flow solution has just turned into a serious personal problem for the director.

Don’t hesitate to talk to your client manager if you need clarity on this issue.

 

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This newsletter has been produced by Stanley & Williamson as a service to its clients and associates. The information contained in the newsletter is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this newsletter, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under Professional Standards legislation.